Quantitative easing - All posts tagged Quantitative easing

You thought it was gone. Officials declared it dead. Nobody ever expected to see it again. Then suddenly, shockingly, late one night, it came back to life and laid waste to everything in its path.

It sounds like a bogeyman tale fitting for Halloween. But in this case it’s quantitative easing that’s been reanimated and is bringing havoc to financial markets worldwide. Overnight. the Bank of Japan surprised everyone (why do some central banks still insist on doing that?) by massively expanding its asset purchase program in the latest effort to shock its moribund economy back to life. At the same time, Japan’s $1.2 trillion public pension fund announced an enormous shift out of bonds and into stocks.

The BoJ move comes less than 48 hours after the Federal Reserve declared its own quantitative easing efforts dead by concluding its bond-buying program on schedule. Japan’s effort to fight domestic deflation seemingly dates back to the dawn of time, and this represents the latest of endless rounds of quantitative easing there. Similarly the European Central Bank just initiated its own QE program, marking the start of an expected period of exceptional divergence of central-bank policy worldwide.

Stocks have soared across the globe as a result of the BoJ move, while Treasury bond prices have taken a hit. The 10-year note is down 7/32 in price to yield 2.328%, per Tradeweb data, and the 30-year bond is down 18/32 to yield 3.064%. The dollar is strong, the yen is weak, and gold is getting hammered, again.

European Central Bank President Mario Draghi, now reportedly shopping for corporate bonds.

Treasuries are weakening this morning following a report that the European Central Bank plans to buy corporate bonds as part of its developing bond-purchase program. Andreas Framke, Eva Taylor and Paul Carrel of Reuters report this morning that the ECB “is considering buying corporate bonds on the secondary market and may decide on the matter as soon as December with a view to begin purchases early next year.”

The ECB on Monday embarked on its first bond-buying measures, buying covered bonds - a type of bond popular in Europe and typically backed by mortgages – as part of its effort to boost the European economy. The program is modeled after the Federal Reserve’s quantitative easing programs, which had focused on Treasuries and mortgage bonds, not bonds issued by companies.

The 10-year Treasury note is currently down 10/32 in price to lift its yield to 2.218%, per Tradeweb data. The 30-year bond is down 15/32 to yield 2.983%.

The Financial Times today features an interview with Jeffrey Gundlach, (subscription needed) in which the DoubleLine founder looks ahead to 2020 and paints a gloomy portrait of an economy that will still be coming to terms with the unintended consequences of today’s easy-money central banking ways. The FT’s Stephen Foley reports:

When a bond market maven says “interesting”, be scared. What is good for fixed income is rarely good for the economy as a whole, and Mr Gundlach has a whole list of interesting: a wall of high-yield debt that companies will need to refinance; soaring federal government deficits as baby-boomers drain social security and healthcare funds; ageing populations in China and other emerging markets; and the Federal Reserve’s Treasury holdings maturing, too.

His conclusion? By 2020, the Fed may well be resurrecting quantitative easing, its palliative for troubled markets.

“It seems like one of the consequences of this zero interest rate policy is you’ve pushed out the problem of refinancing, of rolling over, but you’ve really compounded the magnitude of it and it seems to be focused around the 2020s.”

Gundlach made a prescient and contrarian call earlier this year that interest rates would fall rather than rise, in 2014, which has helped his flagship fund, the DoubleLine Total Return Bond Fund (DBLTX), gain 4.84% this year to date, per Morningstar, beating the 4.00% return of the Barclays Aggregate index.

Gundlach aslso thinks the economy isn’t nearly as healthy as some recent data would suggest. He says forecasters and equity markets will eventually stop clinging to the notion of robust, accelerating growth, and hints that he may have punched some pumpkins in his day:

They cling to the idea now, he says, “and then all of a sudden they won’t. It’s kind of like punching a pumpkin. It’s the same thing, the same thing, the same thing and then all of a sudden it all caves in. I would still be surprised to see full-year 2014 GDP exceed 2 per cent.”

Shorter-term government bonds are better this morning amid hopes that the Fed might consider lowering its target unemployment rate that it has said will determine when it will start raising short-term interest rates.

This hope stems from a research paper, co-authored by William English, who heads the Fed’s monetary affairs division, that has been making the rounds in fixed-income circles this week. In it, English and his co-authors argue that the Fed would be better served in its effort to create jobs by lowering the current 6.5% target unemployment rate it has set for raising short-term rates, with the unemployment rate now down to 7.2% but the economy still fragile. If the Fed did so, it could keep short-term target rates lower for longer and further aid the economic recovery. Wall Street Journal Fed guru Jon Hilsenrath examines the issue in today’s paper:

The paper lays out a range of scenarios that show short-term rates not rising until late 2015 but suggests an “optimal” policy might keep rates near zero as late as 2017. “Reducing the unemployment threshold improves measured economic performance,” the paper argues.

Fed officials have been discussing for several months whether to lower the unemployment threshold as a way to convince markets that they will keep short-term interest rates low for a long time. They want investors to believe interest rates will stay low even as the economy strengthens and as the Fed winds down its $85 billion-a-month bond-buying program, which is also aimed at spurring economic growth. Minneapolis Fed President Narayana Kocherlakota has called for a 5.5% threshold.

San Francisco Fed President John Williams expressed skepticism Tuesday about changing the threshold. “I’m not sure in this circumstance that changing the language from 6.5 to a lower number would actually tell people on its own anything different than we’re saying now,” he said.

Bonds are welcoming the possibility of further Fed accommodation, after a string of unexpectedly positive economic data in the past week has pushed rates higher again and refocused attention on when the Fed might begin tapering its $85 billion monthly bond purchases. Shorter-maturity Treasuries are benefiting the most this morning, while the long bond is weaker. With the 5-year Treasury note up 6/32 in price to yield 1.343%, per Tradeweb data. The 10-year Treasury note is up 3/32 to yield 2.651%/ The 30-year bond is down 11/32 to yield 3.779%.

Just when you thought it was a done deal that the Fed would start tapering its monthly bond purchases at its upcoming policy committee meeting, in comes a disappointing August jobs report. And suddenly everything’s back in question again.

“This report certainly throws a monkey wrench into the market’s thinking as to what the Fed may do,” writes Adrian Miller, fixed-income strategist at GMP Securities. “More important, how will the Fed interpret these numbers? There is no denying the fact that even with a solid job report, the true health of the labor market is quite suspect with recent job gains being in lower paying positions at less hours while the duration of unemployed remains too high. And now with a weak August report many of the FOMC participants who have been sitting on the fence will sound out a chorus of ‘no taper’. And yet, with QE providing little economic support and only serving to further distort asset prices, the cost-benefit equation still calls for a taper regardless of lackluster growth and clearly unimpressive job gains.”

Miller bets the Fed still pulls the trigger on “a small taper” on September 18th. “Initially we expected a $15 billion cut in purchases, but perhaps this job report has dropped that to a mini-taper of $10 billion.”

Similarly, Tom DiGaloma, head of fixed income rates sales at ED & F Man Capital Markets, thinks the report was bad but not bad enough to derail the Fed’s tapering plans. “This was a horrible set of jobs figures,” DiGaloma writes, citing the large downward revision to July’s jobs number and a drop in the labor participation rate to the lowest level since 1978. “Despite this weak report the Fed will most likely taper in September.”

Using the ten-year Treasury yield as an indicator, the bond market already seems to be moving back toward its previous tapering expectations. The yield had crested at 3.005% overnight, per Tradeweb data, topping the 3% mark for the first time since July 2011. It had slipped to 2.955% right before the release of the jobs report and then immediately fell further upon the report’s release to 2.869%, as markets questioned whether the data will be strong enough to induce the Fed to start tapering. Now it’s creeping back up again, checking in most recently at 2.921%.

A pair of Deutsche Bank economists – chief US economist Joseph LaVorgna and senior US economist Carl Riccadonna – today analyze the Fed’s current tapering and tightening trajectories and see a fair value range of 3%-3.25% for the ten-year Treasury yield.

Deutsche Bank says the the recent decline in the unemployment rate “has clearly been faster and further than policymakers expected,” so either the Fed will soon begin to reduce its quantitative easing bond purchases or else the Fed will reverse course and begin downplaying the drop in unemployment, possibly abandoning the central bank’s 7% unemployment rate target for QE completion. From Deutsche Bank:

In the case of the former, the fixed income market is likely to continue to look past the Fed rhetoric that tapering is not tightening. The market appears to believe that when it begins, each day of tapering is one day closer to fed funds rate increases. In other words, as long as the economy is improving, term premium has to rise, and this will be reflected in higher yields.

If we assume the Fed raises interest rates in early 2015 (about six months ahead of the FOMC’s central tendency forecast), then we target fair value on the 10-year Treasury note to be between 3% and 3.25%. Given that we have already surpassed our prior yearend target of 2.75%, but we expect back-half real GDP growth to improve relative to the first half of the year, we envision further back-up in yields over the next several months. Consequently, we currently target 3.10% 10-year Treasury yields by yearend, which is close to the midpoint of our fair value range. However, this range is not static; it changes based on the fundamentals, namely expected economic performance and the Fed’s anticipated response. The fact that the 10-year Treasury to fed funds spread is so wide means the yield on the former can only go so high as long as the Fed is on hold; the loss of carry is simply too large.

Treasury yields just spiked immediately after the release of the Fed’s latest policy committee meeting minutes. The ten-year note, which had recovered to unchanged on the day at 2.814% right before the minutes’ release, is now down 12/32 in price to yield 2.862%, per Tradeweb data.

One thing to remember about the market reactions to Fed meeting minutes is that it usually morphs through the course of the next hour or so – the minutes defy a quick, easy algorithmic read and instead the market interpretation tends to progress through the afternoon as people actually read the full text. (See, for example, how gold immediately freaked out a little before changing its mind.)

That said, early reads are somewhat bearish and seem to suggest the Fed is more comfortable with the idea of tapering. Here’s Peter Tchir of TF Market Advisors:

It seems like tapering is coming. The Fed still seems a bit concerned about growth and not at all afraid that inflation is coming in any which way. We will see what is priced in, but I think we will see pressure on the 10 year treasury, possibly driving it to 3%. That will drag down corporate bonds, push CDS wider and ultimately pull stocks down as well, led by dividend stocks.

The market is giving the best impression that this is priced in, but too many were looking for a bounce into or after the numbers, that I just don’t think we will get it, and the day will end worse than it is now.

Treasuries are halting their multi-day slide so far Tuesday, with the 10-year note 15/32 higher in price to lower its yield to 2.827%, per Tradeweb data, and the the 30-year bond up 19/32 to yield 3.867%. This comes after Treasury yields moved sharply higher Monday. Strategists are attributing Tuesday’s rebound to increased foreign demand, after rising yields made Treasuries more attractive as a safe haven, particularly amid ongoing weakness in emerging markets. Here’s Adrian Miller of GMP Securities with his take:

Just when you thought there were little to no buyers for presumed safe haven global bonds where bond yields have been on a seemingly vertical path higher, Tuesday is witnessing a clear shift in sentiment as investors have become increasingly concerned about the fate of emerging markets. Weakness across currencies and equity prices of emerging market regions is not necessarily a new phenomenon, but after a protracted downdraft since May investor’s attention is growing. As we have said previously, the distortion among asset class prices resulting from long term global central bank liquidity was bound to be equally intense when the punch bowl was about to be pulled away. Indeed, since the Fed began hinting that a scale down of QE3, which in turn has resulted in a jump in bond yields across most developed markets, the flood of liquidity that poured into emerging markets in search for yield has been moving the other way.

While the ten year broke through key support at 2.87% [on Monday], the secondary move was not especially severe, and in overnight trading before Tuesday’s session, we quickly bounced back. Some value buyers are starting to find current levels attractive, despite the JPM Client Survey (net long positions in the Treasury markets decreased to -2 from +6 last week) showing a more bearish sentiment. It’s hard to make an argument to buy aggressively ahead of FOMC minutes Wednesday and the Jackson Hole conference on Thursday into Friday.

The ten-year note fell 14/32 in price to finish the day at 2.765%, per Tradeweb data, after hitting an intraday high 2.819%, the highest level seen since July 2011. The 30-year bond lost 30/32 in price to lift its yield to 3.806%.

Speaking on Bloomberg TV today, Pimco bond guru Bill Gross said he sees an 80% chance that the Fed will begin tapering its monthly bond purchases in September, adding that investors should expect the central bank to hold short-term rates near zero into 2016 or even beyond.

“We think that future Fed policy will increasingly rely on what is now being called forward guidance as opposed to asset purchases or quantitative easing,” Gross said, echoing his previous Fed criticism by calling QE “a tired horse which has inflated asset prices but done little to stimulate real growth.”

Gross, who manages the Pimco Total Return Fund (PTTAX), sees a reversal of the Fed’s 2011 Operation Twist, in which the central bank bought long-term bonds and sold short-term bonds. Now, Gross says, “the Fed wants the market to buy 1- to 5-year securities with the comfort of forward guidance, and they’re withdrawing the purchasing of 85% of the gross issuance of 20- to 30-year Treasuries. So the advantage, if this diagnosis is correct, is that long Treasuries and long maturities should be sold, and 1-5 year, 1-10 year maturities should be bought based upon this transition.”

More from Gross:

When there’s a lot of leverage in the economy, a central bank must tread lightly in terms of raising interest rates. That’s why we’re seeing the emphasis on forward guidance and that’s why we’ve seen quantitative easing. And so the historic raising of interest rates to countermand higher inflationary threats, basically is a thing of the past. So we think the Fed stays where they are, at 25 basis points, for a long, long time, perhaps 2016 and beyond.